Yuan edges up as surprising fixing sends warning to bears

Published Wed, May 15 2019 1:27 AM EDT

SHANGHAI, May 15 (Reuters) - China's yuan edged up against the U.S. dollar on Wednesday, with investors discouraged from testing further lows in the currency after the central bank set a stronger-than-expected fixing. While the midpoint was weaker than the previous day, the market had expected an even weaker fixing. The yuan has lost more than two percent since the flare-up in Sino-U.S. trade tensions, which has renewed global financial market concerns over how much China will allow the yuan to weaken to offset heavier pressure on its exporters. Analysts believe the authorities will keep depreciation in check for now due to concerns about potential capital outflows. Prior to market opening on Wednesday, the People's Bank of China (PBOC) lowered its official yuan midpoint to 6.8649 per dollar, 284 pips, or 0.41 percent, weaker than the previous fix of 6.8365 and was the softest since Dec. 27, 2018. Market participants have noted that recent official fixings have persistently come in much higher than market consensus. On Wednesday, the midpoint was 142 pips firmer than Reuters' estimate of 6.8791. Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong, said the higher-than-expected fixing was largely due to the effect of the "counter-cyclical factor". "The counter-cyclical factor has been in place recently to slow down the pace of yuan depreciation. It was not meant to reverse the course, but to ease the pace of losses to let the market better accept the yuan's weakness," Cheung said. "The central bank is fine with yuan depreciation only when it happens in an orderly manner," he said, but he added that 7 per dollar remains a critical level for the authorities. Counter-cyclical factor, a tool first introduced to the midpoint fixing formula in May 2017, was widely believed to reduce price swings and counteract yuan weakness. In the spot market, onshore yuan opened at 6.8750 per dollar and was changing hands at 6.8731 at midday, 22 pips firmer than the previous late session close but 0.12 percent weaker than the midpoint. The renminbi hovered around the offshore closing price, while investors tracked news headlines for any signs of progress in Sino-U.S. trade negotiations. "Market sentiment was actually better than last year, as we have not seen large-scale panic corporate dollar buying so far," said a trader at a Chinese bank. In the past, major state-owned Chinese banks had steadily sold dollars directly in the spot market to prop up a falling yuan. Or, they swapped dollars for yuan in onshore currency forwards, tempering depreciation expectations by containing the yuan's price in the forwards market. The central bank was also widely believed to have effectively tighten yuan liquidity offshore to raise the cost of shorting the yuan to arrest the losses in the Chinese unit. But traders said they have not seen any of these activities so far. "Higher (than expected) fixing reflects the central bank's attitude, but offering dollar liquidity is a real action in the market. It seems the central bank is only sending a signal of its attitude for now," said a second trader at a Chinese bank. "As long as the Chinese authorities think that a deal is still possible, we think they will prevent the currency going through seven per dollar," Capital Economics said in a note. "But if tariffs are ultimately implemented on all U.S. imports from China, there would be little to gain from continuing to push back and something to gain from allowing the market to weaken the renminbi." The offshore yuan was trading at 6.9 per dollar as of midday.

*Divergence of the dollar/yuan exchange rate. Negative number indicates that spot yuan is trading stronger than the midpoint. The People's Bank of China (PBOC) allows the exchange rate to rise or fall 2 percent from official midpoint rate it sets each morning.

OFFSHORE CNH MARKET

Instrument Current Difference

from onshore

Offshore spot yuan 6.9 -0.39%*Offshore 6.937 -1.04%

non-deliverable forwards

**

*Premium for offshore spot over onshore

**Figure reflects difference from PBOC's official midpoint, since non-deliverable forwards are settled against the midpoint. .